Isn't America Already Financially Repressed?


At CNBC, Antonia Oprita finds out about the newest horror in government profligacy from aptly named HSBC economist Stephen King. Now that faux-sterity has spooked the rubes, "financial repression" may be the only hope for the developed world's morbidly obese governments: 

"Financial repression results from policies which allow governments to fund their borrowing through imposing costs on others," King wrote in a market note.

Governments could use regulations to force banks to lend more to the government while liquidity-pumping policies – such as quantitative easing – push bond yields down even when fiscal policy is out of control, allowing governments to avoid being punished by markets for lack of fiscal discipline, he explained.

The 1950s and the 1960s were, for the Western world, a period when financial repression seemed to work, as government debt fell rapidly. "This, however, was more a happy coincidence: debt fell rapidly for other reasons, allowing economies to shrug off the effects of repression," King wrote.

If applied today, repression is likely to starve the private sector of funds, as the rapid reduction in debt seen in the '50s and '60s was a consequence of bumper growth which brought in tax money rather than of government borrowing crowding out the private sector, he warned.

How would low interest rates reduce debt when they encourage more borrowing? In an interesting NBER paper [pdf] from M. Belen Sbrancia and the formidable economist Carmen M. Reinhart say it's a function of reduced debt service cost: 

Financial repression includes directed lending to government by captive domestic audiences (such as pension funds), explicit or implicit caps on interest rates, regulation of cross-border capital movements, and (generally) a tighter connection between government and banks. In the heavily regulated financial markets of the Bretton Woods system, several restrictions facilitated a sharp and rapid reduction in public debt/GDP ratios from the late 1940s to the 1970s. Low nominal interest rates help reduce debt servicing costs while a high incidence of negative real interest rates liquidates or erodes the real value of government debt. Thus, financial repression is most successful in liquidating debts when accompanied by a steady dose of inflation. Inflation need not take market participants entirely by surprise and, in effect, it need not be very high (by historic standards). For the advanced economies in our sample, real interest rates were negative roughly ½ of the time during 1945-1980. For the United States and the United Kingdom our estimates of the annual liquidation of debt via negative real interest rates amounted on average from 3 to 4 percent of GDP a year.

It seems to me we already have a massive program of directed lending by a captive audience in the form of a Social Security "trust fund" that takes money out of every paycheck and puts it into low-interest federal debt. Governments may be able to force lending, but the way to reduce debt is to stop borrowing money. 

King notes that repression "may well redistribute the burden of adjustment from debtors to creditors via unusually low real interest rates but, in itself, is unlikely to be enough to deliver a major reduction in government debt as a share of GDP."

It's also worth noting that the period when repression apparently worked to decrease debt-to-GDP ended with a long, severe recession that discredited the Keynesian consensus and introduced a new word – "stagflation" – to the language. That seems like a steep price to pay for more Solyndra loans, Secret Service agents' hookers and GSA junkets in Las Vegas.